What Minimum Wage Opponents Get Wrong about Economics

Opponents of the minimum wage frame their argument in terms of oversimplified economic theory that is not borne out by empirical research. The argument goes like this: raising the minimum wage distorts the fair market value of labor, making it expensive for employers to hire low-skilled workers. Employers respond by laying off workers and hiring fewer new ones, which causes unemployment. If you abolish the minimum wage instead of raising it, you give workers more opportunities, more bargaining power, and more economic freedom.

There are several problems with this argument.

First of all, if you really care about the economic freedom of low-wage workers, you should care that 71% of Americans and 87% of low-wage workers support raising the minimum wage according to a Gallup poll. The minimum wage is an expression of low-wage workers’ economic freedom, not a hindrance to it.

Now, minimum wage opponents respond to this by pointing out that low-wage workers aren’t economists and don’t really know how these things work. But that’s a self-defeating argument because it undermines a basic assumption of their economic theory: that workers are efficient and rational economic actors capable of negotiating a fair price for their labor.

In fact low-wage workers tend to be inefficient actors, especially when it comes to bargaining. Employers however are expert bargainers, which is how they got to be employers. So in the negotiation between workers and employers to set the price of labor, workers will often get cheated. They’re just not skilled or empowered enough to extract the fair value of their labor.

So what the minimum wage does is draw a line beyond which employers cannot cheat their workers. It says, “You can cheat your workers this far, but no farther.” In this sense it’s a market correction rather than a market distortion. It’s an aid to workers in an imbalanced negotiation in which employers have most of the bargaining power.

Another problem with anti-minimum-wage logic is that right now in the United States we have a situation where nearly all the money is in the hands of the wealthiest. If they already have all the money, then there’s no incentive for them to invest that money in producing goods and services. Increasing the minimum wage puts more money in workers’ pockets, which increases consumer demand for goods and services, which increases the incentive for the nation’s wealthiest to invest their money in production and in hiring more workers. In economic terms, the minimum wage’s positive effect on employment due to increased demand helps offset its negative effect on employment due to increased labor costs.

When you look at actual data on minimum wage increases, you find very mixed results. Many studies find a negative effect on employment, while many others find a positive effect or no effect at all. But even studies that find a negative effect show it as fairly small. For instance, a frequently cited study by David Card and Alan Krueger showed that a 10% increase in the minimum wage would lead to a 1% decrease in employment for minimum wage workers. But even subtracting that loss, a 10% minimum wage increase still results in a net 8.9% income gain for this lowest quintile of workers. The gain would benefit 99% of current minimum-wage workers and would improve overall income equality. Americans should take that deal.

Of course, there is a point of diminishing returns in every area of economic policy. Minimum wage opponents like to point to American Samoa, where rapid increases of the minimum wage led to a sharp decline in employment, especially in the tuna canning industry. It ceased to be cost-effective to pay workers to can tuna, so companies laid a lot of workers off. That’s an argument against large or rapid minimum wage increases, but it’s not an argument against incrementally increasing the minimum wage or indexing it to inflation as Obama and Romney have proposed. And it’s certainly not an argument for abolishing the minimum wage altogether.

We probably won’t know where the point of diminishing returns is unless we come to it, and if that happens then we can adjust our policy accordingly. The goal of minimum wage policy should be to find the wage rate that maximizes benefit to low-wage workers without triggering large decreases in employment. In other words, we should be looking for that magic number that best approximates the fair market value of low wage labor. We’re not there yet.

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Comments

““You can cheat your workers this far, but no farther.” In this sense it’s a market correction rather than a market distortion.” I LOVE THIS. people just want to make moral judgments on who deserves how much money, but it’s only bc we’re accustomed to the idea that min wage is 7 that we get offended by someone asking to raise it to 15. if it was at 15 already, people would assume that’s the amount that should be given. thanks for sharing!

A concise and elegant argument. I would add that employers have the power to write the contract while employees never get to write the contract in that segment of the labor market.

Since the contracts are take-it-or-leave-it offers, the resulting market economy is a power disparity, which is incompatible with the market values. As employers can split the cake any way they please, that is no longer a voluntary exchange but a domineering relationship.

Someone on Facebook asked about the minimum wage’s impact on prices. According to a recent survey of twenty empirical studies, “most studies found that a 10% US minimum wage increase raises food prices by no more than 4% and overall prices by no more than 0.4%. This is a small effect.”

A rise in food prices of 4% is a large impact on the low wage workers in this country. If this is such good policy, why are there not more states and localities implementing it? There are many higher minimum wage cities in certain areas, but results are certainly mixed.
I think that one of the worst aspects of high minimum wage is that there are few entry level jobs for teens in many parts of the country with high unemployment. They will not learn good work skills while young and be stuck near the minimum wage when they finally do get a job.

They’re not implementing it because they’re controlled by conservatives or have bought into the simplistic economic theory my post described. A 4% increase in food prices is not insignificant, but it doesn’t wipe out the gains that a 10% minimum wage hike would bring.

There are lots of states and localities that are not controlled by conservatives that still use the US minimum wage. Some even have greater than 3% of workers making the minimum.
You are correct that the 4% food price increase does not hurt those who get a 10% wage increase. But it also negatively impacts the 95+% of other people who also see the price increase and do not automatically get any pay increase. Their purchasing power goes down by 4% in the food portion of their spending.

I think the article may be ignoring the fact that incremental changes can result in rapid, irreversible results. I am not an economist. I am a physicist, so I may be drawing some analogies in my head that are unwarranted. Let me know.

Here is my suggested scenario. All numbers are made up, but they illustrate my point. Say you can make a machine that will completely automate fast food production for the equivalent of paying a team of workers $5/hr. That is less than the minimum wage, but owners don’t automate because of the high upfront costs and disruption to their business during installation. If minimum wages are increased slowly, there still reaches a point where owners say, “This is too much. I am buying the machine.” That point will depend on the owner. Maybe a significant number start switching when the minimum wage hits $12/hr. As more owners automate upfront costs come down, leading to more automation. All those workers are out of a job. Trying to lower the minimum wage to get those jobs back will not work since the machines are already installed. It is now way cheaper to keep using them that rip them out to hire people.

I am not saying that raising the minimum wage must be a bad idea. I am suggesting that some care should be taken in raising it. Even incremental changes could lead to huge job losses if a “phase transition” is triggered..

If increasing the minimum wage only had the impact of raising the cost of production of similar groups of products (or services), then I would say “Fine…that just invests all consumers in improving the conditions for those workers.” HOWEVER, I believe there should be strong incentive for employers to expand and not reduce the number of entry-level jobs they provide. Raising the minimum wage clearly reduces the number of those entry-level jobs. This especially impacts the employment of teens–the very workers we should want out there learning how to work at a job they dislike enough that they will pursue higher education! Maybe if a raise in minimum wage included allowances for holding onto or increasing the opportunity for entry-level workers, then I could be far more supportive.